How to Make Your Letter of Intent Work for You
This sixth and final part of “The Art of the Deal” examines how to establish a letter of intent.
Buyers tend to be experienced in their offering process and their greatest challenge is to maintain “deal discipline.” They need to maintain basic valuation criteria and think of every deal as needing to be structured in a manner that an outside capital group or a board of directors would support in terms of the valuation and economics of the transaction. Sellers tend to be inexperienced; most entrepreneurs get to sell the culmination of their business career’s effort only once.
While “value may be in the eye of the beholder,” the market for recurring monthly revenue (RMR) is very liquid and has not varied radically over the last 20 years with regard to the valuation ranges that accompany good economic sense for varying sized companies.
In both cases, buyers’ and sellers’ interests are best served when they each have professional consultants, brokers and attorneys that are very familiar with these industries. While not complicated in form, the security and fire businesses have unique contractual issues, obligations and deal terms that facilitate the transfer of these assets or business. While this may appear as a business development plug for those professionals, in reality we have seen many transactions that went sideways when professionals unfamiliar with these industries got involved.
Consider the letter of intent (LOI) as an invitation to date and get to know each other. Buyers should work from the seller’s representations to fashion the basis of the offer in concert with their deal disciplines. The traditional LOI should focus on some of the following aspects of the planned transaction:
- Clear definition of the RMR contracted services under consideration
- Clear definition of what a performing account looks like
- Clear definition of any other assets or liabilities to be included
- Escrow arrangement (if any)
- Valuation terms as to pricing and payment terms
- Outline of any holdback provisions — value, time and qualification terms
- Allocation of proceeds for tax purposes
- Discussion of proceed deducts — adjustments for deferred revenue, prepaid expenses, etc.
- Assumption of specific liabilities, if any, and clear exclusions set forth
- Non-solicitations from seller and key members of seller’s team whether they are intended to “come with the deal” or not
- Business continuity provision during negotiations
- Offer is “subject to buyer’s successful due diligence, at buyers discretion for a fixed period”
- Set forth any financing contingences and board approvals necessary for buyer and/or seller
- Seller standstill provision during buyer’s due diligence period
- Representations of seller as to RMR content, concentration, attrition, personnel, etc. that seller has described to date
- Broad discussion of indemnifications that will be sought from buyer and seller
- Confidentiality of both parties and related professionals
There is nothing more daunting for a prospective seller than to be taken through a 15-page LOI over lunch if this is his or her first and only planned transaction. Make sure the form of the LOI matches the deal sophistication of the audience. As the buyer, you will have plenty of time to pour over a lengthy purchase-and-sale agreement. This stage of a deal is about building a business relationship of trust and respect between the parties.
As a seller you may want to have a better handle on the level of due diligence that the buyer plans to conduct. In most cases, the seller does not need to inform their team of a proposed transaction. There is nothing wrong with the need for confidentiality until a binding purchase and sale agreement has been executed between the parties.
In all cases, seek an industry-experienced attorney by the purchase and sale stage of any transaction. With all due respect, the sale of one’s business is not comparable to the documenting of the sale of a parcel of real estate.
In a competitive market, buyer discipline is very important. Remember that the best deal you may ever do is the “one you let get away” by not continuing to match higher offers of others in “the hunt.” Maintain your valuation and margin assessments discipline unless you are buying into the industry to establish a platform business and are willing to pay a premium. The best contribution economics you can ever hope for fall into the realm of a fold-in acquisition of customers that lay over your existing infrastructure. You will never achieve better returns, so don’t delude your deal discipline into believing you can.
Whether you are heading into your first deal or are on your 20th, each deal is different because of the parties involved and the differing levels of business experience of those parties. As a buyer, maintain your discipline; and as a seller, be knowledgeable of the facts that accurately describe your opportunity from the outset and be patient in your search for the right buyer.
If we haven’t touched on an aspect of the Buying or Selling of a company and the associated Due Diligence, please don’t hesitate to reach out for us at our website – www.TRGassociates.com.
About the Author: John Brady is principal of TRG Associates Inc., Old Saybrook, Conn. Since its inception in 1991, TRG has been successfully assisting a wide range of security and fire alarm companies, entrepreneurs, lenders and investors in due diligence and acquisition planning. If the articles in this series have not touched on an aspect of buying and selling that you are interested in learning about, you may reach out to the author through TRG Associates’ website at www.trgassociates.com.
The Art of the Deal
With the security and fire industries still very fragmented and continuing to grow, the acquisition opportunities within the United States and Canadian markets continue to be very active. As importantly, the capital markets continue to be very supportive of both industries when they identify capable management teams to back.
The predictable cash flows associated with the recurring monthly revenue (RMR) in these industries are the “crown jewel” that drives impressive operating margins. Author John Brady, principal of TRG Associates Inc., Old Saybrook, Conn., has been privileged to perform a vast number of valuations and due diligence efforts on behalf of buyers and sellers over the past 20 years and identifies what he has found to be the important aspects in the “art of the deal” in this six-part article series.
While maintaining a disciplined approach to evaluating a seller’s business is critical, there is an art to buying a selected group of RMR customers. This article series explores the important aspects of that art:
1. What should go into any acquisition valuation of RMR and the company as a whole? What revenue has value?
2. How does the attrition history of the seller impact the level of due diligence and ultimate valuation?
3. In performing due diligence, cash is your key indicator as to the health of the target company and the associated RMR. How do you analyze that important asset?
4. How does the buyer assess the installed technologies and signal platforms of the seller’s customers and what effect do those have on valuation?
5. How does the buyer assess the service expectations (obligations) and economics of a customer base? You won’t change those expectations overnight so assess carefully.
6. The letter of intent: how to fashion the art of the deal in a “hot market” versus practicing prudent investment principals.